Financial analysis of the "Competition Bikes Inc." company

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22nd May 2017

This case analysis will tackle the financial areas of the company "Competition Bikes Inc.", it includes the detailed explanation of the company's benchmark financial statements and evaluates how the company is performing. This case analysis will also explore areas of improvements in the company and provide reasonable recommendations in order to suggest effective methods of operation and necessary actions.

Abstract

Control will also be analyzed in terms of evaluating the company's recommended measures and corporate systems appropriate for internal control. The use of working capital, risk evaluation and government regulations affecting business would also be tackled. This paper will explain the differences and the variables showing in the summary reports and explain how the company is performing in terms of financial data.

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It is important to dissect the financial reports by performing horizontal and vertical analysis to identify the problematic areas and appropriate actions needed to address the weaknesses. This paper will be presented in a comprehensive manner that is easily understandable for the investor's point of view and assess if the company is losing or gaining. The importance of this case study is mainly to identify key factors affecting the business operations in terms of the financial situation. The main goal of this case analysis is to answer the "why" and the “how” questions in discussing the elements involved in Competitive Bikes Incorporated business operations.

Introduction

For this case study, the company to be analyzed is the Competitive Bikes Inc., a manufacturing company of professional bicycles which caters specifically for the competitive use such as races, biathlons and triathlons. It is crucial for any business to analyze financial performance to gauge if the business is losing or gaining money from its operations.

The company has been very successful in penetrating the intended market even though the ratio of bikers using their product competing in such sports event is only at 10%, but surprisingly, about 60% of CB bike users do win in the competition. This sparked interests to many bike athletes to consider the brand instead of the other competing names in the business such as the Two Wheel Racing Inc. The word of mouth among the biking community has been an effective tool used by the company to continuously offer quality bike products to their customers. This also enabled the company to reduce the cost of advertising since the previous users themselves are the one's testifying for the brand of its quality, primarily because of ratio of users against the winners.

The company was founded by Larry Ferguson in 2001 in his own garage. Ferguson is a biking enthusiast who is constantly seeking a suitable bike that is lighter, much more durable, and on top of that, is affordable. Larry Ferguson's company was proven to have a strong potential for financial success, but can only be proven once the analysis of the company's financial data was presented. This paper intends to go over the report summaries of the company to check where the company is indeed gaining profits or instead losing too much. By identifying the strengths and weaknesses of Competition Bikes Incorporated, we can make a clear picture of their current financial situation and make recommendations of which areas needs to be improved in order to continuously anticipate growth.

The company currently has two main locations in San Diego, CA, and Atlanta, GA. In terms of distribution networks, Competition Bikes Inc. is channeling products through retail distributors and strategically chose from the wide array of distributing partners to ensure that 95% of the U.S. population would have an access to their products and quality service. Product delivery is equally important for the company because it always makes sure that the new products would be able to reach the customers before they go out of style. Network distribution is done through an accredited contracted carrier which is more experiences and superior in handling product delivery. The goal of the company is mainly to produce reliable, light-weight and durable bike frames and components of the highest quality as possible.

But apart from the aesthetics of their products, Competition Bikes Inc. must also consider cost in their manufacturing line. The way they describe their products represents high-end raw material requirements that are most of time more difficult to obtain if not too costly. The balance between the cost of manufacturing and sales must meet in a certain point to ensure profit. If the raw materials are too expensive and the product's retail price doesn't match the price, the company would eventually face financial loses. That is the main objective of this paper, to discuss in details all the elements surrounding the financial environment within Competition Bikes Inc.

This paper will present a comprehensive explanation of the company's financial statements by looking into several segments such as costing, sales forecast, cash flow and working capital. This will also include cycle factors in cash conversion, operating cycle and free cash flow. At the end of this case analysis we would be able to determine if the company is at the progressive trend of financial outputs and inputs. Expansion plans and product development will also be discussed in this paper to better understand the feasibility of the long term plans and how it impacts the company.

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Task 1 Financial Statements Analysis

A.1. Competition Bikes Inc. Operational Weakness and Strengths

Using different methods in analyzing the company's financial methods such as horizontal, vertical, trend and ratio we would be able to identify both the weaknesses and the strengths in the company's business operation. Financial analysis provides evaluation of the company's performance and points out the areas of improvements and be able to come up with recommendations needed to improve the methods of operation. This is because analysis is the benchmark of financial statements, without which the company would not be able to see a clear picture of how well or bad they did implementing operational practices.

A.1.a. Horizontal Analysis Results

The comparative results showing on the income statement from year 6, 7 and 8 at every end of the year (December 31) shows inconsistency. Starting from the first line on net income, from year 6 to 7 there was an increase of 33.3% on year 7 which is a difference equivalent to $1,496,000 of net sales from year 6. However, year 8 showed a negative net sale of -15% as compared from year 8 or $897,000 lower than year 7. But to compare year 8 from year 6, evidently year 8 is still 13.33% higher or a difference of $598,000. The trend is not consistent in such a way that even though year 8 is relatively higher than year 6, but lower than year 7, it goes to show that something could have gone wrong on year 8 which explains why it wasn't able to at least match the net sales of year 7.

For the cost of goods sold within the three-year period, there is also an indication of decline in year 8 primarily because the sales on year 8 are also relatively lower. On average each year shows that the percentage of goods sold versus the net sales is constantly between 72-73%, but year 8 showed that the cost of goods sold is lower than year 6 and 0.40% higher than year 7. The possible cause of this is the constant ups and downs on the price of raw materials. But the fact that the company was able to manage limiting the difference in the cost of goods consistently within the three-year period is a good sign of strength, but low net sales on year 8 is quite alarming.

One of the possible reasons why the company had quite a drastic decline in sales on year 8 has something to do with decreased efforts in areas such as advertising. Evidently the increase on advertising budget from year 6 to year 7 came at 37.5% or a difference of $8,940 from year 6 to 7. This increase on advertising contributed to the increased sales that had happened in year 7, but come year 8 the company reduced operational expense on advertising of up to 16.3% or a difference of $5,332 from year 7 to 8 and this reflects almost the same percentage of decline on net sales between the same years. It also explains why the company had low sales on year 8 is because they didn't focus on advertising on year 8 as shown the net sales difference. That area became the weakness of the company that resulted in negative comparative sales.

Another weakness that the company demonstrated as reflected in their three-year financial statement is the way they reduced the budget for product development. The data indicated that there were 16.3% or equivalent to $15,996 reduction on research and development on year 8 which should have not been the case, because in order for the company to continuously obtain new markets they must not stop developing new product ideas through research and development. Once a company stopped practicing the principles of innovation, they are not cutting cost but instead limiting the possibilities of diversifying product portfolio, thus limiting possible market share gains and sales. Other indication of weakness is the increased in General and Administration expenses and utilities expenses which were overseen by the operations management. If the sales are low, a domino effect would eventually follow. Low sales mean low in production and the use of utilities should be relatively lower as well including administrative expenses which should not deteriorate the overhead margins of operational cost of sales and production is low. The utilities expenses increased by 11% and administrative expenses by 7.6%, despite low net sales in year 8 in comparison to year 7.

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The only strength that Competition Bikers Inc. demonstrated based on horizontal analysis is the increase in cash and cash equivalents of 275.4% on year 8 as compared to year 7. This is a complete opposite of the results from year 6 to 7, because during this period it shows that there is a 54.6% decline on cash and cash equivalent from year 6 to 7 most probably because the company has to exhaust resources in order to meet the increased demand of the product on year 7. Apparently, year 8 was a slow year for the business and the only reason why the cash equivalent assets increased is because the stock inventory of unsold products from year 7 rolled forward to year 8 which is also a form of cash equivalents.

This can be regarded as an advantage because the company will have the opportunity to control production outputs depending on the sales trend on year 9, thus allowing the company to limit the expenses for the cost of goods, labor and general expenses. Oher observation in the horizontal analysis is the decrease in long term liabilities which appeared constant at -5.9%. However short term liabilities have increased 33.3% on payables bring the total short term liabilities at 28.5%. Shareholder's equity on the other hand shows positive retained earnings of $36,100 or equivalent to 3.1%.

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